As we have on many occasions, today we are going to share with you some interesting thoughts from our respected friend Brian Wesbury. You may recall that he is the Chief economist at First Trust Advisors. The wrinkle in our referencing Brian today is that he is, in turn, referencing a friend of his — who is also an economist and is someone Brian generally agrees with. Today however, things are little different. Let’s take a peek at their interesting, but opposing, points of view.

Brian opens his comments with this:

As far as Harvard economist Martin Feldstein is concerned, we’re all doomed.
Feldstein says that the low interest rates of the last several years have created a stock market bubble rivaling the housing bubble that precipitated the last crisis. As interest rates keep rising, he says, the stock market bubble will eventually burst, sending the economy into another “long and deep downturn.” But, unlike in the prior recession, with interest rates still relatively low, the Federal Reserve will have less room to respond to a weaker economy.”

Feldstein lays his argument out succinctly enough and it is hard to say that he is simply wrong. After all, there are a lot of forces at play. But we think Wesbury successfully rebuts Feldstein’s basic premise: The stock market today looks like the hyper-valued real estate market of a decade ago. So, the argument really is one of estimations of value. Here’s Brian:

“We like to assess fair value in residential housing by comparing the asset value of owner-occupied homes to the annualized rent these homes could earn. Using historical averages, our calculations suggest home prices were about 40% above fair value at the end of 2005. With US homes valued at about $21 trillion, that meant an overvaluation of about $6 trillion. (Note: When an asset is priced 40% too high, it takes a loss of 28.6% from the overvalued level to bring the price down to fair value.) For perspective, GDP was $13 trillion that year.

By contrast, the stock market is not even close to that kind of overvaluation. At present, the price-to earnings ratio on the S&P 500 is 22.3. The average in the past 40 years is 20.2. So even if you accept the P-E ratio as the gospel (and we don’t), equities only appear about 10% over-valued.

Except the current P-E ratio only reflects two quarters of the tax cut so far. The forward P-E ratio is 16.9, which leaves room for a 20% rally in equities just to get back to the 40-year average of 20.2 (assuming earnings estimates are accurate.) Moreover, the average P-E ratio of 20.2 over the past 40 years was established when the yield on the 10-year Treasury Note was averaging 6.26%, not the 3.06% it’s at today. In other words, bonds were a much more attractive alternative to equities in the past than they are today.”

Wesbury does put a caveat on the whole discussion though:

“We’re sure the economy will eventually face another recession. It may even be a deep one, although our best bet is that the next recession will be mild compared to the last. When it happens, the pessimists will tell you how they got it right all along. But getting it right, briefly, at least a few years from now is not worth losing out on the gains to be made in the meantime. Those who stay long equities will be rewarded.”

That’s the way we see it too.

Market Minute – Perspective – What Saith the 500-pound Gorilla?

The Index (S&P 500 Index*) fell sharply this week as did bonds. As humans we seem to always look at the most recent happenings and project them ahead into the future. So, let me do that for you. If the Index fell the same amount every day for the next 3.5 months as it did yesterday, stocks would be worthless in 3.5 months. Seems pretty silly I think. So, think about this. The index is about 2% from its most recent 52-week high which happened late in September. New highs are characteristic of bull markets. So, this is hardly a correction, and certainly not a pullback. It’s more like a one-day decline.

So, here’s my take. I am a bit concerned with the weakness in the Smallcap part of the markets, but (at this time) the S&P 500 Index is holding up and looking just fine. And the Index is the 500-pound gorilla as it represents the bulk of all traded stocks in the US. The bull market will not end until the gorilla sings.

Ronald P. Denk, CFP®
Investment Advisor

Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk
www.denkinvest.com

This weekly article reflects news, commentary, opinions, viewpoints, analyses and other information developed by Denk Strategic Wealth Partners and/or select but unaffiliated third parties. DSWP provides Market Information for illustrative and informational purposes only. If you wish to receive this weekly commentary by email please contact us at 602-252-8700 or by e-mail at lindaw(at)denkinvest.com. If you are receiving this commentary via email and would prefer not to please let us know either by email or phone.

Ronald Denk is an Advisory Representative offering services through Denk Strategic Wealth Partners, A Registered Investment Advisor. He is also a Registered Representative, offering investments through Lincoln Financial Securities Corporation, Member FINRA/SIPC.

Denk Strategic Wealth Partners is not affiliated with Lincoln Financial Securities Corporation. Information in this commentary is the sole opinion of Denk Strategic Wealth Partners. Past performance is no guarantee of future returns. All market related investments involve various types of risk, which include but are not restricted to, credit risk, interest rate risk, volatility, going concern risk, and market risk.

The Update provides information of a general nature regarding legislative or other developments. None of the information contained herein is intended as legal advice or opinions relative to specific matters, facts, situations or issues. Additional facts, information or future developments may affect the subjects addressed in this document. You should consult with an attorney, accountant or DSWP planner about your particular circumstances before acting on any of this information because it may not be applicable to your situation.

Lincoln Financial Securities and Denk Strategic Wealth Partners and their representatives do not offer tax advice. Please see your tax professional regarding your individual needs.

*The indices are representative of domestic markets and include the average performance of groups of widely held common stocks. Individuals cannot invest directly in any index and unlike investments, indices do not incur management fees, charges, or expenses, therefore specific index returns will be higher. Past performance is not indicative of future results.

LFS-2268621-100518